MONEY MANAGEMENT

OK, this is the money management part of the Discipline/Money Management presentation.

The first thing I want to talk about is MARGIN.

You really have to be adequately capitalized when trading or you will be trading from fear. We got run out of our 9th trade because we didn’t have enough money.

One of the things that really bother me is when I see new traders say, “I am switching to XYZ broker because I can trade the ES for only $500 margin per contract. I know that person will likely not be successful because they simply do not have enough capital in their account.

Personally, I use a figure of 5X the amount of required margin per contract in my account. Some people say that is too conservative. For me, that is what I am comfortable with. It makes trading easy for me, since I am never looking at my equity balance if I know there is enough margin to cover it. That again is just me personally.

This is an example of something I use for money management. The guts of money management are really extremely important. Because it allows you accomplish one of your real goals in trading. YOUR REAL JOB DURING THE DAY, IN ADDITION TO TRADING, IS PRESERVING YOUR CAPITAL. There is nothing more important and that’s the reason why for some of us who have been traded a long time, we don’t think about trading without hard stops. We have been around when the market has gone against us for a day or two or three, and WE COULD HAVE BEEN OUT OF THE MARKET WITH A STOP BEFORE THE CASCADE STARTED.

The WIN RATE and the AVERAGE GAIN OR LOSS RELATIONSHIP is really important to understand and I am going to show you an example of why this is so important. You never take a loss caused by the “HOPE MODE”. What happens, as you have heard many times, is what Woodie has said many times. The hope mode becomes the “dammit” mode, then the break the PC mode. For many people, it means going back to a 9 to 5 job working for somebody else again. Most of us who are traders have many reasons. One of the big ones is to have the freedom to do what we want when we want to do it. I think that is why most of us are here. This is why it is important you understand this next part.

I am talk about why the Percentage Win Rate and the Average Win and Average Loss figures are so important.

The next slide is one that I’ve given to many new traders in the room who have had a difficult time understanding the concept of Risk Reward and Money Management and why the Average Win and Average Loss figures are so important and that the Average Gain has to be bigger than your Average Loss. This is the exercise that many people on the chat have done and is what I have given them.

What you are trying to do is what we have seen - to get 5-6-7 white bars in a row when you are long. If you keep getting white bars (close above prior bar close), then keep the position until you get a red bar.

If the first entry bar that you have closes lower than the entry, you immediately cover.

What is happening? This system will actually make you money. Why does it work? It works because you will be long and short an equal number of times. You have no bias to either the long or short side. You will immediately cut your losses if your first bar is a loss but if it is a winner you will let it run.

All I am saying if that if you take random entries by being long or short and you practice good money management you can take this system home and you will find that it will make money for you. THIS IS THE IMPORTANCE OF MONEY MANAGEMENT. You have no choice being long or short and totally unemotional. You are reading no signals. You simply are taking advantage of the fact that you are going to be wrong for one (1) bar all the time, but when you are right, you might be right 3, 4 or 6 bars. This is the system that I gave to Blinky several weeks ago. Then the light finally came on. If you have seen his trading in the last three or four weeks, he has commented several times that this is what finally turned the light on for him.

This is the final chart that I am going to show. It shows the importance of the average win versus the average loss and the importance of closing your stops as quickly as possible.

What this chart says is: Let’s say you put a stop loss in based on the ES, this slide says that if you take a 1 ½ point gain every time it is offered you must be right 50% of the time, before commissions, to break even. Now what we really see quite often, in the chat room, is someone reporting their 1 ½ point stop (6 ticks) and as soon as
they get a one (1) point profit, they get out. 60% of the time you must be correct to break even before commissions

Now, let’s see what happens if you say “OK, I’m going to put in a 6 tick stop but I am going to wait until I get a 2 point gain which is 8 ticks. You only have to be right 46% of the time.

What I have done is color in the yellow area as the area in which I don’t think it is possible for anyone to make money. If you are a trader always taking a stop loss of 6 ticks, and you are always running after you make 3 ticks – you have to be right 67% of the time before commissions to break even.

And every day we see people taking small losses, even though they are taking the full 1 ½ point risk – the initial stop. It also shows you how important it is to move your initial stop loss quickly. Let’s say you when you take the trade and you have a 6 tick stop loss. Then the trade starts going with you a little bit. CCI has hooked in your direction and everything looks good. If you can move that stop down just to 4 ticks instead of 6 ticks, then you only have to be right 40% of the time to break even before commissions.

Taking small losses is really a very big secret.


IN CONCLUSION ---- Keep your trading simple and focused.
Have a trading plan AND FOLLOW IT.

------ Write it down in the morning.

------ This is what I am going to do today.

------ This is what I am going to trade.

------ This is how many points risk I am going to take.

----- Define how and when you are going to exit.

And stick to it. Don’t take any other trade during the day. This is an area where newer traders are often undisciplined. Be adequately capitalized. Those are my rules that I think are effective for a new trader to be successful in this business. It is a tough business.

Comments related to Questions:

(1). When I take a position while trading – there is a stop in. If the market goes
against me I am out. Woodie says, “If you are wrong, get gone.”

(2). In my discussion on getting out on a CCI signal, my favorite signal is get in and
if the trade goes in my favor, I want to ride that trade as long as long as I
possibly can. If that trade goes for me and for example CCI goes to extreme,
that is when I will get out since that probably is the maximum I will get out of
that trade.

If I get in a trade, let’s say I am long, the market starts to go with me, and I see
it bounce off the zero line – I will abandon the trade. It’s done – it’s rejecting it.

(3). The 30/34 strategy was a fall back system I presented to the room a while back.
It would usually produce 2 to 2 ½ ES points a day. Last year, I could see that
I was no longer able to beat the simple Stop and Reverse. I used to be able to
take 45-50 points but that started dropping down. The swings were narrowing.
That is why I said “Let’s abandon it at this point”. At that point, always take
30 points was not beating the stop and reverse. If the situation reversed and
again we are back to the area where 35 point targets ( or higher) beat the stop
and reverse, I’ll get back in again. You need large swings to make it pay.

(4). With the lower volatility markets of today, I am trading all in and all out.

(5). If we have time tomorrow maybe Woodie can talk about covered calls. This is
not the right time to do it now.

(6). GB and Woodie both discussed the reasons for contraction in prices recently.
The topic is interesting but not pursuant to the title of the presentation and so
I am not going to include it in the notes.

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